Sunday, November 20, 2011

For all of us that believe that competitive economic markets are a good thing, here are some questions and thoughts which I think need to be asked and investigated...

First off, let me say that my hypothesis is that competitive markets will not exist for very long when the market makers (the buyers and sellers) are dynamic, evolutionary (ie. adaptive) decision makers motivated by their desire to make money for themselves.

Question: Why aren't people talking about the the failure of the competitive marketplace for senior management salaries?

I have heard an argument for high salaries that goes like this: We pay our senior managers these high salaries because we have to. There just aren't enough senior executives out there, and we have to stay competitive.

Now, in the short run, this may make some sense. But in the long run, this seems a strange argument. Senior managers are just like other scarce resources. For other scarce resources, companies work hard at becoming less dependent on them. For example, if we change out the words "senior managers" for another scarce resource, let's say "laborers," then companies would be saying: We pay our laborers these high salaries because we have to. There just aren't enough laborers out there, and we have to stay competitive.

Hmmm... I might hear that argument in the short run, but in the long run, I haven't seen that happen. In most other job markets, when the number of people available to fill positions gets scarce, either more people are trained to fill the positions, or the companies find a way to live without the positions. When a resource gets scarce, the companies, driven by their profit motive, work hard to find alternatives. In the case of rising labor costs, we saw companies switch over to alternatives (mechanized labor and/or cheaper off-shore labor).

When was the last time I heard a company say, "These senior managers are getting too expensive. Let's find an alternative."

The competitive market is failing in the domain of senior management salaries. I don't think I have to go too far to convince you of the main reason the market is failing. The decisions about where to focus a company's innovation is controlled by the very same senior managers the company should be striving to replace. In other words, we have the fox watching the hen house, again!

The competitive market is failing, too, to increase the supply of senior managers. In fact, the best business schools in the country measure their success on the salaries their graduates are able to get! We now have whole business schools who are incented to inflate senior manager salaries because their school's reputation depends on high senior manager salaries.

So, without finding innovative alternatives to senior managers, or increasing the supply of senior managers, it is no wonder that there distorted upward pressure on senior manager salaries. It is this clear conflict of interest and lack of sufficient checks and balances that leads to my suspicion of distorted (aka unfair) salary pricing of senior manager salaries.

Another reason I am suspicious that senior salaries are too high is because I have been a successful businessman. I was trained in college to be a good businessman. Much of my training was about how to subvert the competitive marketplace. As a senior executive, I don't like competition because it lowers the price I can charge for my product. Competition erodes my profits down to zero. To be more successful, I raise my profits by finding ways to beat the competitive marketplace. I am good at my job. And I am good at making sure that I benefit from my labors by subverting competitive pricing of my salary. I am incented to do so, because I want to personally profit from my own labors, like everybody else.

My point is this: senior managers are taught all these strategies to beat the market in school. They're not stupid. They have the training, and they know how to use it. My question is: Who is watching the hen house? Where is the check and balance to watch over this conflict of interest (aka inherent failure of the competitive marketplace)? If your answer is: the Board of Directors, I suggest we look at who sits on the Board of Directors, and where is their incentive to pull the plug on the source of their own income. Where is their motivation, really?

It is interesting that a premise of the competitive marketplace is that people should act in their own profit-motivated self interest. The economic marketplace depends on people being motivated to make money. Why would I expect anything else from all levels of the economic organization? Why wouldn't I expect everybody to want to beat the system and make more money by finding holes, exceptions. We even give these holes a positive spin by calling them opportunities! But these opportunities come with a cost. The cost is that, in a competitive market, the opportunities, those holes and exceptions to competitive markets, are imitated by others anxious to take advantage of the opportunity. This is the flaw in any attempt to regulate evolving systems made up of decision-making agents. If unchecked, if not watched and regulated by an outside influence, and influence outside the economic marketplace, then entire cohorts of agents, entire markets will follow the opportunity, the hole, the exception, the flaw in the system. And the market will no longer be competitive, will not longer serve the community, will no longer yield the benefits heralded by the economic theory of competitive markets.

We are all very clever at adapting to new opportunities. Who will save us from our own self-motivated, profit-driven behavior of finding ways around the very rules established to keep the game fair?

PS: Beware of the wealthy person espousing the value of the competitive marketplace! Wouldn't there be fewer wealthy people if the competitve marketplace was working? One reason I don't trust wealthy people who advocate competition is because I know how secrets and limited access to information are one of the most obvious ways to get around competition. I am suspicious that many wealthy people exploit their access to information that is not available to non-wealthy people, allowing these wealthy people to make money from holes and exceptions that are not known or available to non-wealthy people.

PPS: It is curious that the students of OWS are not occupying the busines schools, or the President's office of their colleges....

Here's another sacred cow that needs to be looked at: Our educational institutions are being overrun with the concepts of competitive markets. For example, salaries of college professors are being tied to salaries of senior managers, allowing salary distortions to be carried over to our educational institutions. But why should we expect college Presidents to be any different than company Presidents when it comes to justifying higher salaries? And then there is the whole issue of schools being poorly suited to the economic marketplace, not because we want them to be, but because the have to be, given the products they produce (education and innovation) and the difficulty of reaping the economic benefit of a college education for a student or community.